Even Business Partners Need a Prenup

What is a buy-sell agreement, and why is it so important? By Doug Bend  This post first appeared on Nerd Wallet’s Advisor Voices.  Many entrepreneurs decide to launch a small business because of the vision and passion they share with a longtime friend or colleague who becomes their business partner. But as with virtually any… Read More

What is a buy-sell agreement, and why is it so important?

By Doug Bend 

This post first appeared on Nerd Wallet’s Advisor Voices

Many entrepreneurs decide to launch a small business because of the vision and passion they share with a longtime friend or colleague who becomes their business partner.

But as with virtually any marriage or relationship, things can change, and you need to be prepared for that possibility – before the honeymoon is over.

A buy-sell agreement is a legal contract between the co-owners of a company that addresses a variety of business-changing events, such as if an owner dies, retires, becomes disabled, or is booted out of the company.

When Things Get Rocky

Just like a prenuptial agreement, a buy-sell agreement is a roadmap that can be used if one or more partner decides to change course. Often, the agreement is drafted at a time when all parties are on friendly terms and in sync on the business’s direction. This lessens the chance of a dispute if things turn sour or tragedy strikes.

When putting together a buy-sell agreement, the parties must decide which events will fall within the scope of the agreement and how each event will be handled.

Two of the more common triggering events include the death or permanent disability of a partner. Even a successful business may lack the cash necessary to buy out an owner’s interest after an unexpected death or disability.

In an effort to plan ahead, owners will often take out life and disability insurance policies on business partners. This way, if one becomes disabled or dies, the remaining owner or owners will have the necessary funds to buy out the partner’s interest.

An effective buy-sell agreement outlines how this will take place. In the absence of a buy-sell pact, a deceased partner’s ownership interest would pass to his or her estate, and the remaining owner could face a long and complicated legal process.

Other important provisions in a buy-sell agreement include how each owner’s interest will be valued and what procedures will be in place if one owner decides to sell voluntarily.

What Needs To Be Spelled Out in the Buy-Sell Agreement

An ownership interest in an LLC or a corporation is considered personal property, which means it can be transferred freely as long as there are no provisions to the contrary in the company’s charter documents or imposed by law.

Having restrictions that force the departing owner to first offer his or her interest to the remaining owners provides a mechanism to ensure the ownership of the company stays in the hands of a select few.

For the agreement to achieve its basic objectives, the percentage of the company that each person owns—and the purchase price of each partner’s share—should be clear and unambiguous.

An effective valuation procedure should provide a means for determining the purchase price of a departing owner, whether the value is defined as an agreed-upon amount by the owners, a formula or through a method using a third party.

There are some factors to consider when drafting a buy-sell agreement. Here are a few key points for your company’s attorney, accountant, and business partners to consider.

  • What are the potential sources of funding for purchasing an ownership interest?
  • Which partners will be included in the buy-sell agreement?
  • Will installment payments be considered for the purchase of an ownership stake?
  • How will the valuation process for each ownership stake be determined?

The final terms can vary depending on a number of factors, including the size and financial condition of the company, the health of the owners and the individual preferences of the partners.

Taking the time to plan now can help you avoid major headaches and disputes down the road. For more information on how you can plan ahead for your business, please contact us at info@bendlawoffice.com.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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B Corp Leadership Development Conference

This week I had the privilege of attending the B Corp Leadership Development Conference (“BLD”) at the David Brower Center in Berkeley, CA. The conference was put on by the team at B Labs with the intent of sharing best practices, key performance indicators, and other developments that are occurring within the community. B Corps… Read More

This week I had the privilege of attending the B Corp Leadership Development Conference (“BLD”) at the David Brower Center in Berkeley, CA. The conference was put on by the team at B Labs with the intent of sharing best practices, key performance indicators, and other developments that are occurring within the community.

B Corps are certified by the nonprofit B Lab to meet rigorous standards of social and environmental performance, accountability, and transparency. Today there are over 1,000 certified B Corps (75 in SF alone, including Bend Law Group), all who strive to redefine what it means to be a successful business.

For those who were unable to attend, here are my thoughts and takeaways from the B Corp Leadership Development Conference:

The “Why” of Your Work

People care a lot more about why you do something, as opposed to simply what you do. This is the heart of good marketing. Informing your audience why you act a certain way helps humanize the business process and creates potential lasting connections with clients.

We were challenged to answer “why do you exist as a business”? Here’s my response for BLG: To bridge the gap between entrepreneurship and legal services. Too often we look to our service providers as exterior help that perform a specialized task separate from the core factors that make a business successful. We exist to show a different path as a firm that pivots and innovates as much as its clientele. We exist to move the needle in legal services in such a way that it’s easier for our clients to feel a part of the process and not experience a break in the business strategy that got them to where they are.

B Corp Certification

We heard an inspiring story from Fireclay Tile around their journey to become a B Corp. It reminded all of us how rigorous and rewarding it can be to pass the assessment. Ryan Honeyman, the author of the The B Corp Handbook, shared a list of helpful tips including which areas of the B Corp assessment test were the most impactful. For anyone considering the certification I highly recommend his consulting services.

Blending Purpose and Profit

After an inspiring talk from Plum, and One World Play Project, I was reminded that if your number one focus is your purpose, you’re probably best suited to be a non-profit. Similarly, if your number one goal is profit, a traditional business structure such as an LLC or corporation is a great fit. However, for those looking to blend purpose with profit, a benefit corporation is a great vehicle.

Financial Benefits

This conference reiterated the financial value that comes from being part of the community. I’ve been able to save 10% on tuition for the LLM I’m seeking in tax at Golden Gate University School of Law (close to $1,000 since we joined a year ago). Other great vendors such as A to Z wines provide awesome discounts on their products. I could write a short novella on the other vendors involved, but it was a helpful reminder that there are perks that have made our wallet a little fuller over the past year.

Work/Life Balance

Every business is a family business. The work we do bleeds into our personal lives and impacts how healthy our relationships are at home. Finding an environment that supports your personal values can pay huge dividends for enhancing your work life balance.

Obtaining the B Corp certification isn’t right for everyone, but for those interested in rethinking the ways we use business to impact our community and workplace, a B Corp just may be the perfect fit.

#BtheChange

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Should I Remain a Sole Proprietor?

Virtually every business owner faces the question of whether to remain a sole proprietor or form a legal entity. Here are a few of the key factors to consider. Formation Costs and Business Operations A sole proprietorship is an informal ownership structure that requires very little in terms of formation or maintenance. When transacting business… Read More

Virtually every business owner faces the question of whether to remain a sole proprietor or form a legal entity. Here are a few of the key factors to consider.

Formation Costs and Business Operations

A sole proprietorship is an informal ownership structure that requires very little in terms of formation or maintenance. When transacting business as a sole proprietor you must obtain the applicable city, county, and state licenses, but it is relatively simple and straight forward to properly start and maintain a sole proprietorship.

In contrast, more sophisticated entity structures such as a Limited Liability Company (“LLC”) or corporation have more stringent registration obligations. Additionally, they require internal corporate governance documents such as an operating agreement (for an LLC) or bylaws (for a corporation).

Liability Exposure as a Sole Proprietor

As a sole proprietor, you and your business are considered one and the same. Thus, as a sole proprietor, you are exposed to unlimited personal liability for all business liabilities and obligations. This means your personal assets may be at risk to satisfy an outstanding business debt or obligation.

Properly formed and maintained LLCs or corporations provide limited liability protection, so your personal assets are considered separate from the business assets. For example, if you form a legal entity with limited liability protection and the business defaults on a loan that you have not personally guaranteed, the creditor’s sole recourse would be to look for collection of the debt from the business assets. They cannot access the personal assets of the business owner.

Combining Resources

If two parties decide to start a business the legal classification is a “general partnership”. The risk of a general partnership is that both partners are liable not only for their own actions, but also for the actions of the other partner. To limit this risk, prudent investors seek out entities with limited liability protection to avoid this exposure.

Even if you intend to remain the sole owner of your business, life happens and circumstances change. By forming a strategy to limit your personal liability early on, you are creating a vehicle that is attractive to outsiders who otherwise might not consider your project.

Taxes

A single member LLC or an S-Corp is taxed as a “pass through” entity. A pass through entity essentially means the profits, losses, and other tax attributes flow through to the owner without any federal taxation occurring at the entity level.

The challenge in California is LLCs and entities that have elected to be taxed as an S corporation are treated differently when calculating the California annual franchise tax. A California entity that has elected to be taxed as an S corporation must pay 1.5% of the net income of the business as its annual franchise tax; a California LLC’s annual franchise tax is based on the company’s gross receipts.

This distinction can be crucial depending on the revenue of the business. In particular, if a business uses a lot of inventory but has relatively small margins, it can be more tax advantages for the business to elect to be taxed as an S corporation rather than as an LLC. For example, if a car dealership has a net income of $150,000, but gross sales of $1,100,000, if it elects to be taxed as an S corporation it would owe $1,500 in California franchise taxes. However, if it were a standard LLC, it would owe $6,500 in California annual franchise tax. 

It’s always important to consult a tax professional when determining which legal entity to select for your business because, as the example above illustrates, you might owe varying amounts of taxes depending on which you select.

Other Considerations

In talking to clients we’ve found that some have really enjoyed a marketing bump by forming a legal entity. For example, if a prospective customer receives a proposal from ABC Inc., they might reasonably assume that it was produced by a shop of 5-10 people, even if it’s really one owner and occasional contractors supporting the business. In contrast, if a customer receives the same proposal from just ABC with no “LLC” or “Inc.” at the end, they might not view the business as a “real business.” Instead, they may assume it is a mom-and-pop shop or a fly by night operation that is not worth paying fair market rates.

Additionally, it should be noted that for liability protection to remain intact, it is important to follow corporate formalities when maintaining your entity. This means ensuring you always sign contracts on behalf of the company, and not in your individual capacity. It’s also crucial that you file your annual franchise taxes on time and that you send in forms such as the Statement of Information when they are due. This helps to ensure no one can claim “Well, Bob wasn’t really operating as an LLC and so we’d ask the court to not provide Bob with limited liability.”

As a sole proprietor there are a lot of factors to consider, and you’re strongly advised to seek out the opinion of a legal and tax professional before acting. Crafting a strategic plan for where you are heading is key to understanding if you’re exposing yourself to unnecessary liability, and if you’re missing out on an opportunity to best set yourself up for success down the line.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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